by Abdulqafar Abdullahi
Friday, March 01, 2013
On January 16, 2013, the new President of Somalia appointed Mr Abdisalam Omer as the Governor of the Central Bank of Somalia (CBS) of the first permanent government of Somalia since 1991. From what I read, Mr. Omer is a highly qualified individual with the necessary experience and qualifications to do this job. May be I am biased, but anyone with a PhD. in Economics is in my good books. The task that is in front of him appears daunting and nearly impossible in the short run. It is to his credit that he agreed to accept this position and is a testament to his sense of duty to his birth nation and may be to his sense of adventure or courage. Reconstituting a reasonable monetary system where none exists may be a challenge that is too big for one person no matter how good he may be unless the President and the government give him the freedom and support he needs to do what he must. This article will focus on the challenges the new Governor is going to face in order to fulfill his obligations.
The office of the Governor of the Central Bank of Somalia is a constitutional office with specific constitutional mandate and responsibilities. Article 123 (3) of the new Constitution assigns the CBS to the following primary functions: produce currency, control inflation, stabilize exchange rates and establish a sound banking system. In addition, the Constitution states that the CBS has full authority to execute the monetary policy of the nation. Implicit in this statement is that the CBS is expected to do its job without political interference. This assurance provides the CBS the independence it needs to do discharge its functions based on what is best for the economic health of the nation. The CBS’s role and responsibilities are clarified and defined by the Central Bank of Somalia Act, 2011.
Mr Abdisalam Omer, Governor of the Central Bank of Somalia
As the new Governor assumes his position, the only function the CBS can implement quickly is the production of a currency but this also comes with its own bit falls and may not necessarily be his top priority at this time. The normal central bank levers to control inflation are non-existent or limited. Stabilization of exchange rates is going to be hard unless the CBS wants to adopt fixed or floating exchange rate regime instead of a flexible exchange rate regime where exchange rates are determined by the market forces.
Establish a sound banking system: The first and most important task of the CBS and its new Governor is establishing a sound banking system before he worries about inflation, exchange rate and currency production. However, this may not be as challenging as it seems. The CBS has the authority it needs to regulate and license banks under the Financial Institution Law No. 130 of 22 April, 2012 enacted by the previous transitional federal government. This challenge is made relatively easier by the fact that there are already quassi-banks in existence that provide some of the services that traditional banks do. The money transfer companies have the financial resources and branches or representatives in every region, town, and village. The first step will be to convert these money transfer companies to banks if their owners so wish and meet requirements under the law. There is also pent-up demand from Somali Diaspora and local entrepreneurs to create banks in collaboration with foreign banks.
Produce currency: It is good that the authority to produce the national currency in going to be in the hands of the CBS and not the politicians or other government officials. Assuming a total control over the national currency is not as easy it seems, then, of course nothing is easy in Somalia. Somalis use different currencies including the US dollar as means of exchange, but Somali currency is also widely accepted. The country is flash with money printed by various warlords and transitional governments along the way. There is probably more post 1990 currency in circulation than there is currency produced legitimately by the CBS. It amazes me that people still accept Somali currency as means of exchange knowing full well that the money they are accepting in exchange for their goods and service may in fact have been printed by a warlord and is not backed by any legitimate authority. The faith in the Somali shilling currently in circulation is based on the expectation that others will accept it and if or when the CBS produces a new currency it will honor the Somali currencies produced since 1990. This expectation complicates the task of the new central bank and limits its options.
A more serious challenge politically is how to deal with new currency created and printed by the semi-autonomous region of Somaliland. The first challenge is to figure out what to do with the money already in circulation in this region and the second is the moral hazard it will create. Once the CBS announces that it will accept all currencies in circulation including the Somaliland Shilling at face value may lead the Somaliland government and others to release more of the currency in their possession in to the market prior or during the currency conversion period which may take number of years to complete. It is a political challenge that will require solution beyond the control of the technocrats running the central bank.
Stabilization of exchange rates: Before the stabilization of exchange rates can be undertaken, the government in consultation with the CBS has to decide what exchange rate system to adopt. Fixed or managed floating exchange rate will be the easiest to stabilize. In both cases, the authorities will establish a fixed exchange rate or acceptable range and then the CBS has to defend it. In other words, the bank will sell or buy foreign currency to maintain a predetermined exchange rate or band. For that, the CBS needs huge foreign currency reserves which neither the bank nor the government of Somalia has. It will also make the inflation control even more challenging since the purchase of a large amount of foreign currency will require supply of large quantities of the national currency to the market thereby increasing the inflation. The only viable option is to have flexible exchange rate system and to intervene in the exchange rate market to smoothen expected fluctuations with occasional sell or purchase of foreign currencies. The bank's moderate stabilization actions may be able to keep the exchange rate within an acceptable range unless there are external forces. This may be sufficient to meet the constitutionally assigned function of stabilizing exchange rates.
Inflation control: In order for any central bank to control inflation it must be able to exert appropriate control over the nation’s money supply. To properly exercise this control, the CBS needs a functioning financial sector. Currency is normally a small fraction of a country’s money supply and deposits in the commercial banks play a much larger role in a country’s money supply than the currency in circulation do. In order to control inflation, central banks have two basic levers in addition to direct regulation of the banking system: a) open market operations where the CBS buys bonds to increase the money supply or sells bonds to reduce money supply b) Bank rate where the bank varies the interest it charges to banks for borrowing from it. Unfortunately, there is no bond market and no banks in Somalia. Even if both were available options, the purchase and sell of interest bearing bonds and charging interest rate to banks to borrow from CBS, would have to meet the constitutional test. Remember that the new Somalia constitution clearly states that Islam is the state religion and no law which is not compliant with the general principles of Shari’ah can be enacted. Of course, if these widely used tools around the world are found not to meet the constitutional test, then one day Shari’ah compliant bonds could be created and fees charged to banks for borrowing from the CBS can be structured to meet this constitutional requirement. This means in the short run, the CBS has no tools to control inflation at least until such time that there is a functioning banking system. Once the financial system of the nation is reconstituted, then the CBS could require banks to keep certain level of idle reserves of money to reduce money in circulation to affect the money supply.
A cursory review of the Constitution, the Financial Institution Law No. 130 of 22 April, 2012 and the Central Bank of Somalia Act 2011 suggests that both laws could benefit from a review in light of the requirements of the new constitution of Somalia.
The challenge of reconstituting Somalia's monetary system is immense, and the new Governor needs all the support he can get.
First the president, the government, and the parliament should give the new Governor all the tools and resources he needs to do his job.
Second, the Governor alone cannot and is not supposed to do this job. He is expected to have the support of expert Board. The President and the Prime Minister should appoint a Deputy Governor and five other members of the Board of the CBS on qualification and experience alone and nothing else. The job of the CBS is too important to subject the appointment of its board and its senior officials to the political and tribal horse trading. In other words, the 4.5 formula which is generally used to distribute political offices and parliamentary seats has no place in these highly sensitive positions.
My prayers and well wishes are with the new Governor and we should all wish him the necessary wisdom and courage to do this tough job.
The author is currently a program manager and a former senior economist in the Canadian public service and a part-time professor of Economics. You can contact the author directly at [email protected] or read his new blog posts www.economicscorner.com.